In the social whirl, you can never be too thin -- or too rich. But on Wall Street even the most attractive stocks can suffer when they get too expensive.
, the unchallenged leader in software to create, edit and share digital images and documents. The company's target audience of "creative professionals" snapped up $1.6 billion worth of Adobe's products in fiscal 2004, an increase of 29%, while earnings grew from $1.10 a share to $1.82.
Meanwhile, the stock has appreciated 64% in the last 12 months, while the
has been essentially flat, and software issues -- as represented by the Goldman Sachs Software Index -- have gained just 5%.
So what's not to like? The lack of a believable upside story. Although Adobe bears are certainly a minority, there is a growing sentiment that it's time for those who own the stock to consider taking some profits -- as well as for those who don't want to wait for a better (read cheaper) entry point.
The case against buying Adobe has at least two legs, the first being that even the generally bullish sell-side analysts who follow the company believe revenue growth will drop by half this year, and they note that some of the conditions that made calendar 2004 so good for Adobe will not recur.
Mark Schappel of KeyBanc Capital Markets was one of the first analysts to express serious reservations about Adobe's valuation, downgrading the stock to neutral in September. His view hasn't changed. "It's a great company, but at 35 times
2006 earnings, it's too expensive. Operating margins are about 35% and I don't see them heading to 40, which is what the stock needs to move," he said in an interview. (KeyBanc is seeking investment banking business with Adobe.)
The second leg of the argument is technical: It appears that $65 has become a resistance point the stock has tried to pierce numerous times but failed. Moreover, volume in Adobe's most recent run-up was too light to support much more of a rally, and the increasing divergence between the stock price and the relative strength index (a ratio of the average upward changes to the average downward changes over time) also indicates that the stock may well head south, said Richard Williams, chief market technician for Garban Institutional Equities.
Adobe's stock got
yet another boost at the beginning of February when the company raised guidance for the current quarter. Adobe said it now expects to earn a profit of 47 cents to 51 cents a share, up from earlier guidance of 45 cents to 48 cents per share. Revenue likely will range from $450 million to $470 million, instead of $435 million to $455 million.
In a note published after the midquarter update, Bank of America Securities analyst Hari Srinivasan illustrated Wall Street's somewhat schizophrenic take on the stock. Srinivasan raised his first-quarter estimates and said that new versions of Acrobat and Creative Suite "provide strong visibility to revenue growth in fiscal 2005." But he added, "While investors may react positively to this news, given slowing growth, tough compares and current valuations, we remain on the sidelines waiting for better entry points." (Bank of America Securities has an investment banking relationship with Adobe.)
Tough comparisons is right. In 2004, revenue grew from $1.29 billion to $1.67 billion, an increase of nearly 29%. And net income rose 69% to $450.4 million. But analysts polled by Thomson First Call peg 2005 revenue at $1.91 billion, an increase of 14.8%.
"Last year was unique," said CEO Bruce Chizen during an appearance at the Thomas Weisel investors conference this week. "It was the first year we had a Creative Suite, the economy was relatively stable, and lots of people were upgrading their computers -- especially Macs."
The Olympics and the national election of 2004 also were big pluses for Adobe because events such as those boost magazine and newspaper advertising, which in turn build demand for Adobe's products. Although there are indications that advertising will remain strong this year, it's not likely that demand for Adobe's products will enjoy as strong a Madison Avenue effect.
Even buy-side analysts who support the stock acknowledge that hypergrowth is on hold -- at least for now. "I would expect the stock to make more modest progress this year since earnings growth will be somewhat slower than last year, said analyst Tony Ursillo of Loomis, Sayles & Co., whose company is a major holder of Adobe. "You can make some money on Adobe, but not a killing," he added.
Similarly, Daniel Morgan, a portfolio manager with Synovus Investment Advisers, believes the First Call estimates for the year are too conservative. But asked if he thought $63 was a reasonable entry point, Morgan said he thought it was too rich. However, he is not advising clients to sell. (Morgan follows Adobe, but Synovus does not disclose positions in individual stocks.)
The distinction between potential buyers and current holders of the stock makes some sense. It's hard to believe that the stock won't appreciate to some extent over the medium to long term given its solid position in the software market. So buyers who picked it up in the days when Adobe wasn't flying quite so high certainly could hold it without too much fear of a long-term correction, although it may take a while to see additional profits.
But buying it now, when sell-side analysts have target prices ranging from about $57 a share to $70 a share, seems like more risk than potential reward.
You won't find many people knocking Adobe or its management. And industry analysts, such as Toby Bell of Gartner Research, who follow imaging software, say that fears of competition from
and other companies offering cheap, or even free competitive products, are overblown.
But chowing down on Adobe at these ultrarich prices might give you fiscal indigestion.